Why Southern Company Is Attractively Valued

Steam rises from the cooling towers of nuclear reactors at Georgia Power's Plant Vogtle, in Waynesboro, Ga. Southern Company and its partners have reached a deal to keep building two new nuclear reactors at the site. (AP Photo/Mary Ann Chastain, File)

Southern Company (SO) and its partners have reached a deal to keep building two new nuclear reactors at the Vogtle site in Georgia.

After several days of drama, Municipal Electric Authority of Georgia (22.7 percent), Oglethorpe Power Corp (30 percent), Dalton Utilities (1.6 percent) and Southern’s Georgia Power unit (45.7 percent) signed an agreement to move forward with the project. That vote was made necessary after Southern announced in August a $2.3 billion increase in estimated project costs.

Oglethorpe had initially voted yes only on the condition that Georgia Power as project manager absorb any further cost increases. When Southern flatly refused, negotiations went into a mad scramble, with deadlines for a deal postponed several times.

There’s little doubt pressure from Georgia Governor Nathan Deal and the U.S. Department of Energy (DOE) played a role in keeping the partners at the table. Deal, who leaves office next year, took to Twitter to urge Oglethorpe “to reconsider its decision before walking away from 7,000 Georgia jobs.”

Meanwhile, DOE stated that it was “prepared to move swiftly to enforce its rights under terms of the loan agreements,” should the partners cancel the project. That’s a very thinly veiled threat to quickly call in the nearly $5.6 billion it extended to the project on favorable terms, a move that would have had immediate and very negative consequences particularly for Oglethorpe.

The arm-twisting demonstrates support for Vogtle in state government as well as the Trump administration is still strong. That could conceivably change depending on the result of Georgia’s November elections. But the partners should still have another year to prove they can keep this project reasonably on schedule and within the new cost estimates.

Specifics of the agreement are spelled out in the Form 8-K filed by Southern with the Securities and Exchange Commission. Specifically, Georgia Power has agreed to pay a slightly higher share (55.7 percent) of future cost overruns between $800 million and $1.6 billion.

Georgia Power will pay 65.7 percent of any overruns above $1.6 billion. And if cost estimates are raised by more than $2.1 billion, the other three partners will have a one-time option to basically put their ownership interests to Georgia Power in lieu of paying their share of costs.

Should that occur, Georgia Power would also have the right to unilaterally cancel the project. Conversely, this agreement entitles the company to 60.7 percent of any cost savings from current estimates, provided Unit 3 goes into service by November 2021 and Unit 4 starts up by November 2022 as now scheduled.

The agreement also excludes costs resulting from “force majeure” events, legal fees and actions taken by other Vogtle owners. And it eliminates the requirement to hold a new partners’ vote on an increase in the construction cost estimate.

The most obvious takeaway from this agreement is Southern has taken on more of the risk of the project. Nothing in this deal poses an immediate threat to meeting management’s current guidance of 4 to 6 percent annual earnings growth, with commensurate dividend increases. But it’s likely many investors will view this as a net negative, which could at least temporarily deepen the stock’s discount to other utilities.

Management clearly has abundant incentives to keep Vogtle on schedule and budget. And it’s also worth pointing out that this summer China National Nuclear Power Company successfully started up a reactor using the same AP1000 technology, while loading fuel at another site for possible launch later this year.

Like Vogtle, these facilities also cost much more and took far longer to complete than expected. But their startup demonstrates that the technology works, if builders can see the projects through.

To date, Southern has recovered financing costs on close to $5 billion spent on Vogtle, after agreeing to eat its share of the overruns announced in August. That roughly $5 billion is what would have been at risk had management decided to cancel the project, and Georgia regulators followed South Carolina’s lead to contest legislation that mandates cost recovery.

This absolute worst-case hit would not have been inconsiderable at 4.4 percent of its total assets. Southern, however, did absorb an even bigger hit from cancelling the Kemper coal gasification plant, and without so much as a downshift in guidance.

The new estimate of $8.4 billion is somewhat weightier at 7.5 percent of current assets. Southern, however, appears to have already covered its share of the additional cost with the pending sale of its Florida electric and gas assets to NextEra Energy (NEE), which follows the sale of New Jersey natural gas assets to South Jersey Industries (SJI).

It’s obvious there’s still a lot of heavy lifting to do at Vogtle. But with few on Wall Street expecting anything good to come out of this situation, the bar of expectations has been set awfully low.

Southern shares, for example, now trade at less than 13 times trailing 12 months earnings, compared to 17.4 times for the Dow Jones Utility Average. The stock also yields 2 percentage points more.

This is a compelling valuation for a company that’s never cut its dividend. That includes the early 1980s, when Georgia Power was forced by regulators to eat more than $2 billion in cost overruns to complete the first two reactors at the Vogtle site.

I make a practice of never recommending doubling down in any one stock. But for those who don’t yet own Southern, the stock remains a buy up to $50.

For disclosure purposes, I’ve owned this stock through its dividend reinvestment plan since the late 1990s. My return over that time is currently 740 percent, or 10.7 percent a year with a roughly 85 percent increase in dividends.

I founded and ran the Utility Forecaster and Canadian Edge newsletters before leaving to form my own publishing company, Capitalist Times. During my almost 30-year tenure, Hulbert Financial Digest routinely ranked Utility Forecaster as one of the best investment newsletters...